Minority Shareholders Archives

The concept of ownership is deeply woven into the American Dream — e.g. own a home, own public stock, own bonds, own a business — so deeply woven in fact that sometimes “ownership” becomes the goal regardless of the consequences attendant to that “ownership.” Yes, when done properly, with due attention to the risks, rewards and ROI (return on investment), ownership can create equity expansion and increase net worth like few other opportunities in our economy.

However, poorly thought out investments in privately held Companies can lead to “dead money”, where the only “return” is pride of ownership and you cannot get your money out. That is, you get to tell your friends and family that you are an “owner of this Company” but in fact you see no financial benefit to this ownership at all! Even worse, such investments can result in a complete loss of the capital invested. Either way, the money is effectively gone, and you are unable to use it in another productive investment. Bad result.

Some points to consider before investing in a privately held company:

Will I ever see a return on my investment?
How will I see that return? (Dividends, interest, appreciation?)
How likely is it that I will actually see that return?
Will I ever get my original investment back?
Can I sell my stock to somebody if I want/need my money (or some of it) back?
At what price can I sell my stock?
How long will that take?
There are many other issues to consider as well.

Adishian Law Group, P.C. assists investors in privately held companies in maximizing the value of their ownership interest and minimizing the risk of capital loss or “dead money.” We assist with the “capital allocation decisions” for both majority and minority shareholder positions, as well as subsequent ongoing management of these investments. If you are contemplating an investment in a privately held company, or you are already a minority investor, we would be happy to talk with you about your options for increasing the value of your shares.

About Adishian Law Group, P.C.

Adishian Law Group is a California law firm with a statewide practice in the areas of Corporate law, Employment law, Real Estate law and Mediation Services. Adishianlaw.com is one of the oldest continually operating law firm websites on the Internet. The firm serves its clientele via three offices located in the major business hubs of El Segundo, Palo Alto and San Francisco. As of March 2013, Adishian Law Group, P.C. has represented individual and corporate clients located across 20 California counties, 4 States outside of California and 9 foreign countries — in over 340 legal matters.

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Minority shareholder rights in California include protections from oppressive conduct by the majority shareholder.

California Corporation Code § 1800 provides several grounds for involuntary dissolution. A court may grant involuntary dissolution where (1) “[t]hose in control of the corporation have been guilty of or have knowingly countenanced persistent and pervasive fraud, mismanagement or abuse of authority or persistent unfairness toward any shareholders or its property is being misapplied or wasted by its directors or officers.” § 1800(b)(4), and (2) “liquidation is reasonably necessary for the protection of the rights or interests of the complaining shareholder or shareholders.” § 1800)(b(5). See also Bauer v. Bauer, 46 Cal.App.4th 1113, 54 Cal.Rptr.2d 377, Stuparich v. Harbor Furniture Mfg., Inc. 83 Cal.App.4th 1268, 100 Cal.Rptr.2d 313, 2000 Daily Journal D.A.R. 10,657.

Involuntary corporate dissolution under subdivision (b)(4) requires a showing that those in control of the corporation have been guilty of, or have knowingly countenanced, “persistent and pervasive fraud, mismanagement or abuse of authority or persistent unfairness toward any shareholders,” or that the corporation’s property “is being misapplied or wasted by its directors or officers.”

Bauer described the course of conduct that satisfies the definition of the improper “squeezing out” of a minority shareholder, thus entitling a minority shareholder to dissolution of the corporation to protect his or her interests. The court took its definition of a from Marsh’s California Corporation Law, the portion quoted by the Bauer court is below:

“The term ‘squeeze-out’ is . . . generally intended to describe a situation where the majority controlling shareholders, who are also the principal officers of a corporation, engage in a course of conduct which is designed to exclude a minority shareholder or shareholders both from participation in the conduct of the corporate business and from the economic benefits derived therefrom . . . The conduct most typically takes the form of refusing to pay any dividends on the corporate stock, refusing to permit the minority shareholder to have any corporate office or position on the board of directors . . . , and the payment of large salaries to the controlling shareholders who are the principal officers of the corporation . . . Obviously it makes a great deal of difference whether dividends had once been paid on a regular basis, but were stopped; whether the minority shareholder had a job with the corporation from which he was fired; and whether the controlling majority shareholders increased their own officers’ salaries, after the rift appeared and the dividends were terminated.” 2 Marsh’s California Corporation Law (3d ed. 1995) § 11.46, 958-960

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Minority shareholder rights in California include protections from a breach of fiduciary duty by the majority shareholder.

Majority shareholders may be held liable for damages for breach of a fiduciary obligation to minority shareholders, Jones v. H. F. Ahmanson & Co., 1 Cal.3d 93, 81 Cal.Rptr. 592, 460 P.2d 464; Brown v. Halbert, 271 A.C.A. 307, 316, 76 Cal.Rptr. 781; and 3 Witkin, Summary of Calif. Law (1960) Corporations, s 99, p. 2390 (1967 Supp. p. 998). A majority shareholder breaches his fiduciary duties to the minority when he uses his control to distribute a disproportionate share of corporate profits (whether in the form of a dividend of excessive executive compensation), depriving the minority of its fair share of corporate profits. See Jara v. Suprema Meats (2004) 121 C.A.4th 1238, 18 C.R.3d 187; Witkin Summary of California Law, Tenth Edition 2. [§ 181].

In Jara, the court found that a minority shareholder had the right to bring an individual action against the corporation for excessive compensation paid to the two other shareholders, who were also executives and directors of the corporation. The court stated, “The objective of encouraging intracorporate resolution of disputes and protecting managerial freedom becomes meaningless where defendants constitute the entire complement of the board of directors and all the corporate officers.” See Jara, supra, at 1259.

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Are you thinking about investing as a minority shareholder in a company? Perhaps you are thinking about taking on outside investors for your current company? What are your minority shareholder rights as an investor? What should you be concerned about as a majority shareholder?

The Minority Shareholder

Understandably, minority shareholders often are concerned that their rights and interests will be trampled by those of the majority shareholders. It seems that corporations appear to have a greater incentive to cater to the needs of their more substantial investors. However, in California, minority shareholders possess certain crucial rights that cannot be compromised by corporate bylaws or majority shareholders actions. One of the most valuable rights for shareholders is the right to access information about the corporation. In particular, shareholders of California corporations have rights to inspect two different sets of records: (I) record of shareholders; and (II) accounting books, records, and minuts of proceedings.

Inspection of the record of shareholders

Minority shareholders have the right to inspect a corporation’s record of shareholders. Those who hold either: (a) 5% of the shares; or (b) 1% of the shares and have filed a federal Schedule 14B relating to the election of directors, have an absolute right, on 5 business days’ notice, to both: (1) to inspect and copy the record of shareholders; and (2) to obtain a current list of the names, addressses and share holdings of the voting shareholders (Corp. C. 1600(a)(b)). Furthermore, any shareholder who does not qualify under either (a) or (b) above, with a written demand, has a right to access a corporation’s record of shareholders. BUT if and only if the acquisition of such records is directed towards an end deemed reasonably related to the holder’s interest (Corp. C. 1600 (c)).

Inspection of the books and records

Minority shareholders also have the valuable right to inspect accounting books, records, and minutes of proceedings. Inspection of said information is provided if and only if the acquisition of such information is directed towards an end deemed reasonably related to the holder’s interest (Corp. C. 1601 (a)).

These are important rights for all shareholders to keep in mind. Indeed, these rights may not be limited by either the bylaws or articles. If a lawful demand for inspection is refused without justification, the superior court can intervene and compel the corporation to forfeit the requested information. In some cases, the courts have exercised their power to award complaining shareholders with reasonable expenses, including attorneys’ fees. (Corp. C. 1600 (b)).

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Many venture backed (and other corporations) choose to incorporate in Delaware due to its well-developed law regarding various common corporate issues. One such issue is a shareholder’s right to inspection.

8 Del. C. Sec. 220

The controlling statute governing shareholder inspection rights is 8 Del. C. Sec. 220, which provides that :

“(b) Any stockholder, in person or by attorney or other agent, shall, upon written demand under oath stating the purpose thereof, have the right during the usual hours for business to inspect for any proper purpose, and to make copies and extracts from:

(1) The corporation’s stock ledger, a list of its stockholders, and its other books and records; and

(2) A subsidiary’s books and records….”

Heavy Procedural Requirements

In order to exercise their rights under Section 220, the shareholder must comply with each procedural requirement of the statute. Like many areas of law there are “procedural” requirements that must be satisfied in order for the individual or entity to receive access to the “substantive” benefits of the law. Here, a failure to comply with the procedural requirements of the statute could result in a delay or denial of an otherwise proper request.

Expedited Process Via Summary Proceeding

Delaware courts have a summary proceeding designed specifically for inspection demands brought pursuant to Section 220. The goal is to promote a quick resolution of any disputed inspection demand for both the company and the shareholder.

Each Case Unique

It is common for shareholders to want information about their corporate investments, and it is common for Company management to want to minimize the amount of information disclosed. Often these differences can be resolved informally, however there are many times where a compulsory court process is necessary. If you find yourself at a stalemate with an inspection demand to a Delaware corporation, we recommend that you contact an attorney promptly. Through our network of attorneys, we can refer you to competent, experienced Delaware co-counsel to advance your case.

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